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Wednesday, August 4, 2010

Pet Insurance is Hard to Justify

With the skyrocketing veterinary costs for pets, many insurance companies are offering pet insurance. However, it's hard to find a good reason why pet owners should buy such insurance.

The main idea behind insurance is to reduce risk. Suppose that you are forced to do a random draw of one ball out of 1000 lottery balls. If you pull the one bad ball, you have to pay $100,000. If you pull any of the other 999 balls, you pay nothing.

It would be nice to buy insurance to cover the case where you pull the bad ball. In a simple analysis, this insurance premium should be $100. Out of 1000 people, we expect only one to pull the bad ball, and then the total premiums of $100,000 would exactly cover the required payment of $100,000.

However, insurance companies have overhead and expect to make profits. They are more likely to charge $200 for this coverage. This illustrates an important point. The total of insurance premiums that you pay is expected to be more than the amount the insurance company will pay out for your coverage. If this isn't true, then the insurance company will go out of business quickly.

It may still be worthwhile to buy the insurance for $200 if having to make a payment of $100,000 would be so devastating to your life that you can't take that chance. This is the real benefit of insurance – covering low probability costs that are so large that they would devastate you.

Getting back to pet insurance, would you really agree to life-saving treatment for Fluffy if it would devastate you financially? I don't mean a $3000 operation. I'm talking about an amount so large that it would devastate you. The answer is very likely no. Of course, any reasonable pet insurance wouldn’t cover extremely costly treatment anyway.

Hang, on you might say. I'd still like to be covered for that $3000 operation. After all, who wants to shell out $3000? Keep in mind that the insurance company will charge much more in premiums than what is needed to cover these operations. Having insurance is very likely to be more costly than just paying as you go.

We make an exception for health coverage on people because we are willing to go to great lengths and expense to save people's lives. As much as we love our pets, few people are willing to go to the same lengths (and costs) to save a pet.

There is an emotional aspect to this that actually makes little sense, but does affect pet owners' decisions. Insurance advertising and terminology create the feeling that having insurance will somehow stop bad things from happening. Having insurance "protection" does not stop bad things from happening. It just pays for some of the treatment. Buying pet insurance will not stop Fluffy from getting sick or injured. Buying pet insurance won’t help Fluffy; it allows you to overpay for treatment in return for reduced volatility of payments.

In the end I suspect that many people will buy pet insurance even though it is a poor financial choice. Between the misunderstanding about how premiums exceed expected benefits and having the vague feeling that pets will be safer if covered with insurance, many will likely buy such insurance.

8 comments:

This is very similar reasoning as to why I don't like life insurance for children. They make it sound like not getting your kids 'protected' makes you a bad parent. In fact the death of a child, although crippling emotionally, is financially a good thing (no more daycare, that's a big expense gone) and insurance is meant to protect you from bad financial hits. It's all about the benjamins, people!

@Geoff: I agree with you, but the way you phrased it may cause some people to react emotionally. While true, few people will react well to being told that the loss of a child is a good thing financially (even among those who have never lost a child). I prefer to say that life insurance for children does not protect the child. The child is no more or less likely to die. Further, the life insurance pay out will not bring the child back. Combine this with the fact that it is a bad deal financially and there is no good reason to buy life insurance for children.

The bigger problem with pet insurance is that it generally doesn't cover the regular stuff - vaccinations, check-ups, stool testing, etc.. Some doesn't even cover regular illness and treatment. They tend to only cover the unexpected - broken limbs, injuries, disease, etc.. So you can't get any value out of it.

The other factor that comes into play with pets is the question everyone asks - "How long will it extend their life?" If you pay pet insurance for 14 years and your dog gets hit by a car, then you still ask yourself the question. If he's only got a year or so to go, then is the pain and rehab worth it even if you do have insurance?

It's generally always better to put $50/pet aside per month. Put it in a savings account. If your pet leads a long, happy life, you'll still have the money. If their health care gets expensive as they get older (which it does), then you have the savings for it. And you can always access that account for regular vet costs.

@Astin: Your approach seems sensible. It's amazing how quickly things have changed. In my youth, few people would spend much money on a vet for a pet. Some would even do a mercy killing themselves and bury the pet in the back yard.

@ MJ - I don't really live in fear of causing people to react emotionally... while at the same time I don't try to incite hatred or anything. But I'll stand by statement as written, because like you said, it's true - my son's daycare cost is $1215 a month, and one doesn't pay daycare for a deceased person. It's difficult to argue otherwise. And I did point out that emotionally such an event would be crippling.

@Geoff: I agree with your conclusions. I tend to see things rationally as you do. This all comes down to whether you want to be right or you want to sway others to the right way of thinking. My suggestion for rewording was designed to sway more people who might have difficulty turning off their emotional blinders.